7th CIRCUIT FINDS THAT INFLATED BASIS SHOULD BE CONSIDERED OMISSION FROM GROSS INCOME GIVING RISE TO 6-YEAR S-L02 / 01 / 2011
The United States Court of Appeals for the 7th Circuit has reversed the United States Tax Court, and found that an overstatement of basis in ownership interests is a omission of gross income under I.R.C. Section 6501(e), thereby triggering a 6-year statute of limitations period. Beard v. IRS, 2011 U.S.App.LEXIS 1575 (7th Cir. 2011). As noted, in the SON-OF-BOSS transactions, the gamble was that the participant could legally increase his outside basis in a partnership interest by not reporting the offsetting transferred contingent liability of the short position on his or her tax return. Noting that some courts have found that the United States Supreme Court's decision in Colony, Inc. v. IRS, 357 U.S. 28 (1958) means that an overstatement of basis cannot be an omission from gross income. Salman Ranch, Ltd. v. United States, 573 F.3d 1362 (Fed. Cir. 2009), Bakersfield Energy Partners, LP v. IRS, 568 F.3d 767 (9th Cir. 2009), Grapevine Imports, Ltd. v. United States, 77 Fed. Cl. 505 (2007)(on appeal). Other courts have disagreed. Burks v. United States, 2008 U.S.Dist.LEXIS 109876 (N.D. Tex. 2008)(on appeal to 5th Circuit), Brandon Ridge Partners v. United States, 100 A.F.T.R.2d 2007-5347 (M.D.Fla. 2007).
Finding that the issue is a contentious one, and a close call, the 7th Circuit held that the plain meaning of the Code and a close reading of Colony leads to the conclusion that given the changes that were made to Section 6501(e)(1)(A), Colony is not controlling, and an overstatement of basis can be treated as an omission from gross income. The 7th Circuit noted that in the Colony case, the facts were different, there the omission occurring in the course of a trade or business, whereas, the taxpayers' omission in Beard was not. As the 7th Circuit views it, Congress intended on giving the IRS a fighting chance in situationers where the taxpayer's return doesn't provide a clue to the omission. As such, according to the 7th Circuit, "the improper inflation of basis is a "leaving out" from any income from whatever source derived" of a quantitative amount proplerly includible. There is an amount--the difference between the inflated and actual basis--which hs been left unmentioned on the face of the tax return as a candidate for inclusion in gross income." Id. at *15. Notably, the 7th Circuit would have granted Chevron deference to both the temporary and final regulations issued which state that in the case of a disposition of property, an overstatement of basis can lead to an omission from gross income.